Providing useful insights and making the complex world of energy more accessible, from an experienced industry professional. A service of GSW Strategy Group, LLC.

Friday, April 29, 2005

Closer FriendsThe relationship between Venezuela and Cuba is deepening. Yesterday, the Venezuelan state oil company, Petroleos de Venezuela (PDVSA), opened an office and local subsidiary in Havana, in conjuction with plans for several oil-related projects in Cuba. President Chavez is solidifying his anti-US alignment, at the same time his country supplies about 1.5 million barrels per day of crude oil to this country. Somewhere down the line, these facts may become irreconcilable, and it will be interesting to see which side initiates the break.

Many international oil companies have significant economic interests in Venezuela, and without their capital and expertise, production of Venezuela's heavy, sour crude oil would gradually taper off. As I've suggested previously, this is a game for only the biggest players, with portfolios able to withstand the potential loss or impairment of these assets. Hopefully, things won't reach this pass, but if they did anytime soon, we would be in for a wild ride on oil prices.

At the same time, anyone expecting Castro's regime to collapse of its own weight must be disappointed at these developments. With a steady oil supply on barter terms, and the prospect of future oil income from Cuban waters, the world's last real Communist country could stave off liberalization for a long time.

Thursday, April 28, 2005

How Much Higher Could Oil Go?After months of watching oil prices edge higher and higher, it is increasingly difficult to imagine a return to lower prices, and correspondingly easier to forecast even higher prices. The Financial Times recently cited Goldman Sachs's suggestion of $105/barrel, as well as mentioning a French bank that thinks oil could go to $350 by 2015. Though the former seems at least plausible, I am skeptical of the latter, having watched similar estimates go down in flames in the past. But I'm also very curious about their assumptions. Those are usually the most interesting element of any forecast, rather than the final number.

What would have to happen for $350 to come true? First, you'd have to guess that the world economy (and especially China and India) will continue to grow at a healthy pace, dragging oil demand along with it. Another decade of 5% growth would expand global GDP by 60%, creating a richer world that might be less price sensitive about oil. The FT article indicated that Caisse D'Epargne sees a global oil supply shortfall of 8%. To make that more concrete, imagine going from today's 84 million barrels a day of demand (and supply) to 102 MBD of demand (2% growth for 10 years) but only 94 of supply. So their world of 2015 is effectively missing the equivalent of Saudi Arabia or Russia.

That would be fine as a disaster scenario, but it's hard to see how you'd ever just grow into a world like this. Supply and demand don't get that far out of whack without some serious substitution or other response that brings them back into line. That might take a few years, but ten? In ten years, with crash programs, the world could close the potential gap with a combination of efficiency savings and non-petroleum energy sources, including oil sands, gas-to-liquids, LNG, and maybe a bit of something more exotic. In fact one risk of this kind of effort is that it would be too successful, forcing oil prices below today's level and making the substitutes uneconomical. When you start looking at things this way, as a dynamic system, it's hard to see $350 oil--which would translate into US gasoline pump prices near $10/gallon--as a viable end state, rather than as a single snapshot out of a longer sequence.

Alternatively, could $350 simply be Goldman's $105 plus a massive dollar devaluation (to something like $4 to the Euro) and a switch from oil being denominated in dollars to the "basket of currencies" concept that OPEC has floated several times in the last couple of decades? The media is currently brimming with commentary from economists who are so concerned about the various US deficits that such an outcome might not surprise them. (I find this a much scarier scenario than the first one.)

In any case, although the last year has brought me around to the idea that high oil prices won't go away soon, I still remember those $100 oil predictions from thirty years ago (in 1970s dollars, not 2005$) that had to be repudiated only a few years later, because they failed to anticipate how consumers and technology might respond. The real wild card in all this is "peak oil", and if that's what le Caisse D'Epargne is thinking, then Mr. Hubbert has won another convert. Whatever their rationale, you have to salute their courage for straying so far from the herd.

Wednesday, April 27, 2005

Do Giant Planes Matter?Today marks another aviation milestone, with the first test flight of the enormous Airbus A380 in France. It's been interesting watching the strategic duel between Airbus and Boeing, with the former opting for a super-Jumbo and the latter for the smaller, sleeker, super-efficient 787 Dreamliner. (Boeing wins on looks and name, if nothing else.) I haven't commented on this matchup previously, since there didn't seem to be any energy implications worth noting. Upon reflection, though, the A380 could turn out to be a significant component of new oil demand in the decades ahead.

When you look back on the air travel revolution of the last several decades, you see the impact of large, long-distance planes--principally the 747--making trans-Atlantic and even trans-Pacific flights accessible for the middle classes of America, Europe and Japan, along with the upper-middle classes of many other regions. Deregulation and competition added millions more passengers to this mix. All of this affected jet fuel consumption.

Between 1973 and 2001, global jet fuel sales grew from about 2.4 million barrels per day to 4.5 MBD, or just under six percent of all petroleum products sold. That doesn't sound like much compared to 20 MBD of gasoline (nearly half of it in the US alone), but remember that crude oil prices are "set at the margin"; in other words, it's the last barrel of demand (or supply) that matters most. The current high prices are largely the result of roughly two million barrels per day of unexpected demand, or lost supply cushion, however you prefer to see it.

So where is all this going? Could a new, dramatically bigger airliner open up air travel to a whole new generation of customers who've never flown before, or at least not with any regularity? Could it help unlock the latent demand for international tourism in China and India, without overwhelming existing airports? Airbus certainly thinks so, if you read their marketing materials for this plane. If the A380 were really successful, it seems reasonable that it might increase global jet fuel demand by a further 20% over the next decade. That would add an extra million barrels a day of crude oil demand and require additional refinery upgrades to translate it into jet fuel, without robbing gasoline or diesel production.

The result of this little scenario is a lot of new tourists, putting more pressure on oil supplies and prices. Am I reading too much into one new airplane model? Boeing would say yes, and if their 787 sales so far this year are any evidence, they may have the last laugh.

Tuesday, April 26, 2005

Another MergerYesterday Valero Energy Corp. announced it was buying Premcor Inc. Neither of these companies are exactly household names, unless you live in a part of the country where Valero has service stations. Nevertheless, the combined company will control about 13% of US oil refining capacity. The logic behind this merger is entirely different from that of the recently announced ChevronTexaco/Unocal deal. While the latter is driven by geopolitics and the need to boost oil reserves, this transaction is simply another in a series of consolidation plays by Valero, which will end up with 19 refineries, assuming no significant divestitures are required to gain approval.

Premcor wasn't new to the consolidation game, either. Its Port Arthur plant, for example, was ex-Gulf, ex-Chevron, and ex-Clark Oil (the precursor of Premcor.) Delaware City, its crown jewel in terms of upgrading capacity, was ex-Getty, ex-Texaco, ex-Star Enterprise (Texaco/Saudi Aramco JV) and ex-Motiva (Shell/Saudi/Texaco.) The beauty of this approach was that facilities that cost billions to build from scratch could be had for pennies on the dollar, sometimes for little more than the value of the inventories in their tanks.

Refining earnings haven't always been as strong as in the last couple of years. For most of the 1990s and early 2000s the disappointing returns in this segment induced the major oil companies to reduce their exposure and sell off many of the plants that are now in Valero's or Premcor's inventory. This made sense, because for most of the majors "integration" has been merely notional--essentially just financial--for some time. These plants were often not running the companies' own crude production, nor were they critical to supplying their marketing networks; instead, they were widely seen as a portfolio drag, and the equity analysts were clamoring for disposals. The absence of integration benefits made it possible for Valero and Premcor to buy these facilities and replicate the rest of the value chain through astute trading, running whatever crude oil made sense each day and selling products to a combination of term and spot customers.

The really significant outcome of this deal would have seemed unthinkable a generation ago: the largest oil refiner in the US will be a company without a single oil well or high-profile brand. The future course of Valero will be an excellent test of that idea from a stock market perspective. When refining margins weaken again, or refineries become subject to another wave of expensive environmental regulations, it will be interesting to see how the market then regards this giant one-trick pony.

Monday, April 25, 2005

Where Have All the Engineers Gone?A recent article in the Financial Times (subscription may be required) highlighted the human resource challenge facing the western oil and gas firms. In the same decade in which they must gear up production to meet growing demand, or find new alternative energy sources, they stand to lose a large portion of their experienced technical staffs. This story resonates deeply for me, having watched wave after wave of downsizing sweep through the industry, and then getting caught up in another one, myself. I don't think the situation is as bleak as the article suggests, because globalization will resolve much of it. But the result will be an industry as transformed as any other on the planet.

When I joined Texaco in 1979, the company had approximately 75,000 employees, operating worldwide. This figure fell after an early retirement package was offered, but ballooned again after the purchase of Getty Oil in 1984. At one point there were well over 80,000 people on the payroll. By 1992, following a series of asset sales, new joint ventures and various downsizing initiatives, the "headcount" had shrunk to 38,000. Texaco was down to about 25,000 employees, excluding joint ventures, when it was acquired by Chevron (35,000 pre-merger employees) in 2001. Today, the combined ChevronTexaco has 47,265 employees.

The picture is similar across the industry. Oil and gas employment in the US peaked at just under 1.9 million in 1981 and was at 1.3 million as of 2002. Of this, the "upstream" sector (exploration and production) has suffered the most losses, about 400,000. Refining and transportation are also down, though retail (gas station workers) is actually up by 100,000, presumably reflecting the shift from old-style service stations to convenience stores.

Sheer numbers aren't everything, though. Technology, productivity and processes have all improved dramatically in the last 25 years. But the same demographics underlying the debate Social Security are taking a toll on the technical workforce of the oil companies. As the FT article indicates, these companies have a big bulge of workers centered on age 50. I was a few years behind that peak, joining the industry at the tail end of the big hiring boom, which was followed by years hiring freezes; for a long time, I was the youngest professional in every work group I joined. The closer that peak gets to retirement, the bigger the challenge for the companies becomes.

Of course the problem isn't entirely due to demography. Attractive early retirement options--in the form of lump-sum pension payouts in a period of low interest rates--have steadily depleted the over-55 ranks, while weak hiring has made anyone under 30 a rarity. The industry's demographic bulge has thus been exacerbated by the unintended consequences of long-standing human resource practices.

It must be a great time to be a chemical or petroleum engineering graduate. Salaries are high, and these skills are in demand. However, it's pretty clear that the key to meeting the ongoing technical needs of the international oil and gas companies won't be found in US or European universities, but rather in the same aspects of globalization that are transforming other industries. Tom Friedman's recent article in the New York Times Magazine talks about a "flat earth," where natural barriers of distance and borders are being erased. Because engineering is focused on the universals of math and science, language is no barrier, either. An Indian engineer sitting in Mumbai or a Chinese geoscientist in Daching can analyze reservoirs and interpret seismic data as well as an American in New Orleans.

For at least the last decade, the leadership of the industry has understood that the international oil companies would have to change to align with the location of the world's remaining oil reserves in the Middle East, Africa and the former Soviet Union. But with the center of gravity of their US and European workforces approaching retirement age, it's a good bet that the shift will happen in ways no one sitting in London, Paris, or Houston would have imagined a few years ago.

Friday, April 22, 2005

Hybrid HumveeLately, whenever I see a civilian Humvee or Hummer H2 on the road , I imagine the number of $20 bills it now takes to fill it up (four!) It turns out that this has been on the minds of the military, too. The DOD has had a variety of programs to boost the fuel economy of military vehicles--some relying on pretty exotic technology--and now there's a prototype of a hybrid utility vehicle that could replace the current Humvee. This would be good news for many reasons.

The Army's concerns about fuel economy are different from those of the average consumer. Money is still an issue, but on a different order of magnitude. As we've seen in Iraq, the cost of a gallon of gasoline or diesel fuel delivered into a war zone is much higher than what we pay at the pump, perhaps as much as $17/gallon. Fuel must be loaded at a local refinery or the nearest port and transported with sufficient security to avoid the kind of problem experienced by Jessica Lynch's unit. Dramatically improving the fuel consumption of military vehicles would shrink the security and logistical burden on the supply chain, in addition to cutting operating costs. It might also allow troops to operate further from their supply lines.

As the article suggests, the civilian spin-offs of this technology could enhance the usefulness and durability of hybrid vehicles already reaching the mainstream. I'll bet Governor Schwarzenegger would love to be their first civilian customer.

Thursday, April 21, 2005

Offshore RefineriesI missed seeing it the other day, but a colleague pointed out this announcement by Saudi Aramco that it intends to build a new 400,000 barrel per day (BPD) refinery at Yanbu, on the Saudi side of the Red Sea. This would augment the existing, comparably-sized Yanbu refinery joint venture with ExxonMobil and push the Kingdom's total refining capacity over 2 million BPD. The project would have lots of interesting implications, if it goes ahead.

There are at least three reasons why the Saudis might want to build a new refinery now. The first and most obvious is that global refining capacity has gotten extremely tight, and refining margins reflect this. Simple refineries that used to make a dollar a barrel are now earning $3, and more complex plants that made $2 or $3 per barrel are making $6-12. Of course, there's a long industry history of destroying attractive margins by building projects that bid up the price of the inputs and flood the market with products. At the moment it would take more than one new refinery to do that.

A more fundamental reason for the Saudis to expand their refinery capacity comes from Econ 101. Traditionally, the producer of a raw material should integrate up the value chain to capture more of the value added on the product. This argument is somewhat shaky in the case of oil, though, because the global oil market isn't in pure competition; the Saudis are price-makers, not price-takers, and as such, they already extract a healthy "rent" from the resource. Until recently, refining margins were depressed globally and earned pitiful returns on capital. And one of the biggest chunks of value in the entire chain isn't available to them at all. A few years ago, the German government took in more money from gasoline taxes than the Saudis made selling petroleum, and this might still be true, as taxes have followed prices higher.

The third rationale may be the most compelling for Aramco, however. It relates to fundamental differences between the crude and product markets. First, when Saudi Arabia exports crude oil, it is subject to their OPEC quota. Although they've been able to produce above that level recently without any repercussions, that's not always the case. Product exports, however, don't count with OPEC.

In addition, most of Saudi Arabia's incremental wells produce heavy, sour oil. This sells at a discount at the best of times, and when the global capacity to handle the residue from refining it maxes out, Saudi Heavy can be hard to sell at all. A new, complex refinery gets around this problem and makes lemons from lemonade: premium products that are in demand everywhere from a feedstock that isn't attractive without a lot of additional investment. The indicated $4-5 billion price tag for the new plant certainly suggests something more than a simple "topping" refinery.

The one piece of advice I'd give anyone looking to partner with Saudi Aramco on this project is not to expect a quid pro quo in terms of access to upstream oil opportunities. That didn't pan out for Mobil or Shell, when they invested in the Jubail and Yanbu refineries in the 1980s, nor are the companies that have signed up for natural gas projects getting any noticeable consideration on the crude side. But perhaps the likeliest partners for this refinery haven't studied that history, having come from a state-controlled company mentality.

Wednesday, April 20, 2005

Strategy vs. TacticsThe lead editorial in yesterday's New York Times criticized the pending congressional energy bill for relying on old solutions to energy security and failing to address climate change, which has large implications for energy. But the editors of the Times also missed a key stumbling block, in their eagerness to cite the prescriptions of various recent reports. Before debating the party of government on tactics, one must convince them that their basic assumptions about energy are wrong, or outdated.

The solution to the energy crises of the 1970s was largely economic, and Republicans are right to recall this. With demand mitigated by reduced speed limits, Corporate Average Fuel Economy regulations, and various energy efficiency incentives, the US then deregulated its oil and gas markets. A flood of new oil production followed. The combination hobbled OPEC's market power for two decades, coincidentally turning oil into just another occasionally volatile commodity.

Today even unfettered access to all the remaining oil resources of this country, including ANWR, will only slow the rate of production decline, while our demand continues to grow. The sole deregulation that would have a truly meaningful impact on oil production would have to take place in the Middle East, and our ability to influence that is a work in progress, at best.

Our other trump card in the 1970s was natural gas. Within a decade, most of the fuel oil consumed in this country was displaced by natural gas, and the fuel oil was converted to transportation fuels in upgraded refineries. Unfortunately, there is no longer a "gas bubble" to tap--unless it comes in the form of LNG that must overcome severe infrastructure hurdles--and any "coal bubble" will be constrained by environmental concerns. In summary, the conventional, supply-based solutions available to us will not prevent the US from importing ever more oil, increasing our vulnerability to foreign suppliers.

Has the strategic dimension of oil grown large enough to override market economics? Even ignoring the possibility of an impending geological peak in global oil production, the global distribution of remaining oil reserves is shifting away from market-oriented countries like the US, UK and Norway and toward the Persian Gulf states, with high-political-risk areas like Russia and North and West Africa holding the balance. Venezuela, one of the key Atlantic Basin suppliers for the US, has turned its solidly professional state oil company into the political instrument of a leader who is starting to look like a Castro with oil. Geopolitics have become at least as import as economics in the oil market.

At the same time, the technology options available to us today are dramatically better than in the 1970s. Hybrid cars and renewable energy are more than just a dream, and alternative hydrocarbon technologies such as coal gasification, oil sands extraction, and gas-to-liquids are becoming mature and proven.

The central question for our national energy strategy is whether the situation we face lends itself to repetition of the successful strategies of the last energy crisis, or if the world and our place in it have changed so much that a new approach is essential. If the latter view prevails, we should be optimistic, because we have a wonderful array of options available to us. Either way the current crisis will eventually end, but it's up to us whether its resolution breaks the cycle or plants the seeds of crises to come.

Tuesday, April 19, 2005

Another HereticStewart Brand is an iconic figure from the 1970s who has succeeded in remaining current and relevant. He is a deep thinker, and a "long" thinker. From his founding of the Whole Earth Catalog, something no true child of the 60s/70s can ever forget, to his role as a co-founder of the Global Business Network, Stewart has long been an influential voice among those willing to question the status quo. Here, with minimal comment from me, is a link to his recent op-ed in Technology Review. In it, he challenges the conventional wisdom of the environmental movement in four key areas. This includes asserting that nuclear power deserves another look, on its environmental merits.

All of this is controversial, but Stewart's environmental credentials are as impeccable as those of the other leaders he cites. Even if you disagree with his arguments, I hope you will agree that this as precisely the kind of debate we should be having right now, as a country, a society, and a global civilization.

Monday, April 18, 2005

Bad OmensThe rate of growth in global oil production over the next two to three years will largely determine whether prices will return to historical levels--in defiance of the current wisdom of the futures markets--or stay in a new, much higher range. Most of the future supply for this period is already "dialed in", with major projects underway in West Africa and the Caspian, and oil sands production ramping up in Canada. The pivot, in my view, is Russia, which has expanded production rapidly over the last few years and has the potential to add more, if it can manage not to scare off everyone with the capital and expertise to make it happen. Current signs aren't good.

During the whole Yukos fiasco, observers wondered whether the persecution and dismemberment of this company was a unique event, targeting one of the "Oligarchs" who had profited enormously from the Yeltsin privatization, or if this simply reflected an effort to put the entire oil sector back into state--or at least comfortably Russian--hands. Most of the PR out of Russia was aimed at supporting the former interpretation. But with BP's big joint venture, TNK-BP, suddenly hit with a $1 bn tax bill for '01 (and more to come?) those who bet on theory number two may feel vindicated.

The other interpretation currently being pushed is that the problem arises from an out-of-control tax agency. That might be right--though it hardly squares with the picture of Vladimir Putin as the man in charge--but it's hardly reassuring. What good is a profitable Russian venture if it can all be taxed away later?

Sadly, it seems little has changed in ten years. In the mid-90s, the big uncertainties for investors in Russia's oil and gas sector were governance and the fiscal/legal system. If Yukos and TNK-BP fit a pattern, things are no different today. All that oil, walled up behind a government unwilling or unable to match progressive rhetoric with meaningful actions.

So Lord Browne is off to chat with Mr. Putin, and let's hope they can sort out this problem. Otherwise, we may be reduced to hoping that OPEC will either realize they've pushed prices too high or degenerate into squabbles for market share.

Friday, April 15, 2005

Market ShapesOne of the great luxuries of being out of the oil trading segment of the energy business is the ability to go days without looking at a screen to check on the price of oil. There are even times when I only hear about it on the evening news, something that would have been unthinkable when I needed to know what it was practically every minute. This is a long way of saying that I had missed the oil market's recent shifted from "backwardation" into "contango" until a friend emailed me an analyst comment to that effect. What does this change mean, and what does it say about the future trajectory for oil prices?

First, a quick explanation of the terminology. In backwardation, the price of the nearest or "prompt" commodity month on the exchange is higher than that of the next month, and so on. Contango is simply the reverse of this. Generally speaking, backwardation is a sign of strong demand or weak supply (or both), while contango indicates a market that is becoming oversupplied. The current market, which not long ago was fully "backwardated", is actually a bit of both today: contango through this September (with a really big May/June delta), and then mild backwardation as far as the eye can see.

What I find so interesting is not just this unusual hump-backed shape, but the fact that the contracts for five years out, which only a year ago were still in the high $20's and six months ago barely broke $40, are still in the high $40s. In fact, you have to get well into 2007 to find anything below $50. Think about that. Somebody (however many folks are buying oil for delivery in 2009 or 10) is betting that demand will outgrow or match the industry's ability to bring on new production for five years! I don't think there have been many five year periods in the last 100 years when that would have been true, barring the "oil crisis" years from 1973 to the early 1980s or WWII. Either there has been a structural shift in the market, or some speculators are going to get seriously burned.

In any case, the market is suggesting a bit of oversupply at the moment, with the expectation that demand will remain strong. Certainly US crude oil inventories are continuing to grow, sitting right at the top of their seasonal-normal range, and gasoline stocks seem to have stabilized. All of this bodes for weaker crude oil prices ahead, and possibly even wider contango, but that may not translate into much relief at the gas pump this summer, because extra crude doesn't translate into extra products if refineries are running close to flat out.

Thursday, April 14, 2005

Which Grade?As gasoline prices climb higher, buoyed by strong demand and high oil prices, many consumers who have habitually bought premium or midgrade gasoline will wonder if they should switch to a cheaper grade to save money. The simple answer is yes, provided your engine doesn’t “knock” or run on after you turn off the ignition. If you are interested in the more involved answer, then read on.

There are many reasons why consumers choose higher octane gasoline, some accurate and others mere myth. Here are the most typical:

I will get better gas mileage on premium. This is rarely true. Premium gasoline actually contains a bit less energy than regular, so you might even end up getting slightly poorer mileage.

My car runs better. If that means it knocks on regular but not on midgrade or premium, then you are right. Otherwise, as long as the gasoline is being smoothly combusted, you won’t notice any difference, especially with modern engines that sense how the engine is running and make minor adjustments continuously.

My car accelerates faster on premium. Not unless it knocks on regular, or the car's owner's manual specifies that it is designed to operate on premium fuel.

Premium gas has better additives and will keep my engine cleaner. This used to be a bigger concern, before the EPA imposed regulations requiring all gasoline to include detergents and other agents to reduce pollution from dirty engines. Some brands still put a bit more additive in premium. If you think you need it, it’s probably a better deal than buying regular and dosing it with store-bought additive.

Now, in addition to the obvious cost differential, there’s another reason to buy lower octane gasoline, and it’s one you won’t hear from gasoline marketers but should be hearing from the government: it takes more oil to manufacture premium gasoline than regular. The explanation requires a short discussion of organic chemistry. (Sorry.)

Crude oil consists of vast numbers of little chains of carbon and hydrogen atoms. These chains come in various lengths, measured by the number of carbon atoms included. The molecules in the gasoline fraction of crude oil generally have between 5 and 9 carbon atoms, with varying numbers of hydrogen atoms. Some of these molecules are “straight”, with each carbon atom connected to only one or two other carbons. Others are “branched”, with some carbon atoms connected to three or four other carbons, and correspondingly fewer hydrogens. Some even come in rings, with five or six carbons in a chain that connects to itself and creates a loop.

The reason this matters is that the branched and ring molecules have higher octanes than the straight molecules, which are more prevalent in most crude oil. (The reference standard for 100 octane is a twisty little guy called “2-2-4 trimethyl pentane.) Much of a modern refinery is devoted to changing the proportions of these different molecules in gasoline, and therein lies the problem. The commonest process for turning low-octane straight hydrocarbon molecules into high-octane rings is called catalytic reforming, or “Platforming.” (Remember the old Shell ads: “Super Shell with Platformate!) Unfortunately, in the reforming process up to 10-15% of the “naphtha”, or raw gasoline, feed is converted into small, low-value molecules that can’t go into gasoline.

This brings us back to our concern about oil consumption. Because premium gasoline requires more “reformate” than regular gasoline, and reformate consumes more naphtha in its production, this means premium gasoline uses more crude oil, perhaps as much as 5% more than regular. As a result of all this, buying lower octane gasoline—if your car can tolerate it—not only saves money, it saves oil, too.

Wednesday, April 13, 2005

Big WindLast Friday I highlighted an extreme form of wind power, flying windmills. This update from MIT's Technology Review shows how the state of the art of stationary windmills is advancing, with power output increasing from under 4 MW per turbine to nearly 7 MW. There is a direct relationship between wind turbine size, power output, and the cost per kilowatt-hour of the electricity generated, and the industry has made great strides moving down this curve. Unfortunately, there is another curve that wind developers must keep in mind: the relationship between wind turbine size and negative public perceptions.

While Europe has forged ahead with wind technology as its fastest growing new electricity source, many US wind projects have been delayed or derailed due to public objections against the intrusion of windmills in favored viewscapes. These clashes are unfortunate, because they divide supporters of the environment over a technology with fewer environmental drawbacks than most other ways to generate the electricity we all consume so eagerly. But even in areas that are more receptive to wind power and its visual profile, there must surely come a point at which bigger is simply too big, regardless of its other benefits.

The trick will be finding the optimal size at which power output is high, cost low, and public acceptance good. As wind turbines approach blade diameters of 140 meters (460 feet--more than twice the wingspan of a Boeing 747), we can't be too far from that point. Finding the right balance is important, if wind power is to remain as a viable alternatives to more coal- or gas-fired power plants and and their associated emissions, greenhouse and otherwise.

Tuesday, April 12, 2005

Climate OpinionHaving followed the issue of climate change during my corporate career and subsequently, I've become convinced that the key issue--at least in terms of action on climate change by the US--is not the science, but the public's perception of the problem. A friend sent me a link to a survey suggesting that the American public remains in a confused muddle concerning global warming and possible responses to combat it. If this is accurate, then the prospects for changing the current policy of relative indifference are poor, barring some catastrophe that can be directly attributed to climate change.

Given increasingly strong evidence that the climate is changing due to human actions, and given consensus in Europe and elsewhere that firm action is required, one might think that our political leaders might be motivated to lead, here. Politicians used to be willing to get out ahead of public opinion on something like this, not just because they thought it was the right thing to do, but because they believed that the personal consequences of inaction would be severe, once the public caught up. However, it's not apparent that our elected officials are at much risk of being voted out of office for having been wrong about something with big consequences. While we may have lots of commissions and embarrass the heck out of them, that's about the end of the line in accountability.

This must sound pretty cynical, and I suppose it is, but it brings me back to my basic premise that until the US public has a clear enough picture of this very complicated issue to want to undertake significant changes in their own lifestyles, it's unlikely that the federal government will do much to deal with it. Perhaps some of the money being spent lobbying on climate change in Washington would be better spent educating voters.

Monday, April 11, 2005

Green NukesNicholas Kristof's op-ed in Saturday's New York Times was hardly the first expression of renewed interest in nuclear power on environmental grounds, but it is still noteworthy, appearing as it does in the great news organ of the Eastern Liberal Establishment (if such a thing exists.) As Mr. Kristof indicates, a growing group of environmentalists on both sides of the Atlantic is coming to see climate change as a greater environmental threat than nuclear power, despite the risk of radiation release and unresolved waste storage problems. This is a remarkable turnabout.

There's also a recognition here that existing nuclear plants are being operated more efficiently and safely than when the public soured on the idea in the aftermath of the Three Mile Island mishap. The industry has been quietly consolidating over the last decade, with companies like Exelon buying up poorly operated one-off plants and turning them into cash cows.

While nuclear power still represents the ultimate in NIMBY reaction potential, I wouldn't be surprised to see the first new plant in the US proposed within the next year or so, probably adjacent to an existing nuke. That would be a real signal that the tide has turned, both economically and environmentally, and a goad for Congress to get its act together on a long-term waste storage site.

Friday, April 08, 2005

Flying WindmillsIf like me you grew up reading Jules Verne, H.G. Wells and Robert Heinlein, then you can't help but love an idea like this. Instead of all those wind turbines cluttering up the landscape, why not put them up in the sky? It may sound like science fiction, but a scientist in Australia is developing Flying Electric Generators (FEGs), as reported by Wired.

The basic premise is similar to that for space solar power. If you want to get the most output from your hardware for tapping a natural energy flow, be it wind or sunlight, then you must place it where the flow is strongest. In the case of wind, that means going to the middle atmosphere, or troposphere.

It's not hard to imagine the objections to this approach. Aside from the visual impact, it's unlikely that the best places for setting up the FEGs will turn out to be entirely uninhabited. Really simple and reassuring safety backups (giant parachutes?) will be essential, because it is far too easy to imagine these things falling out of the sky.

In any case, a company has been established to exploit this idea, though they appear to be having trouble raising capital for it. As the article suggests, though, this is exactly the kind of thing we ought to be considering, because of its enormous energy potential and the absence of harmful emissions or byproducts. And if it seems a bit too much like science fiction, consider how much of today's world would seem like science fiction to someone from the 1950s--even if we still don't have flying cars.

Thursday, April 07, 2005

The Best of Times, The Worst of TimesI'm not sure there's any worse job at the moment than running one of the big legacy airlines. As the Financial Times just reported, the global airline industry is expected to lose more than $5 billion dollars this year, with high fuel prices as a major contributing factor. This will bring cumulative industry losses since 2001 to roughly $40 billion. It's hard to think of any business in the world that is so central to modern life and yet so unprofitable.

And it's not as though the business environment has been bad. It's one thing to lose money in a year like 2001, with the economy reeling and a major terrorist event shaking the public's confidence in flying. Instead, we see passenger miles growing nicely on the back of strong global economic growth, and we see airlines starting to queue up to buy the latest offerings from Boeing and Airbus.

Competition has been the real killer, amplified by absolute fare transparency via the internet, not high jet fuel prices. The traditional airlines are unable to raise fares to cover higher costs, because of pressure from established economy carriers like Southwest and upstarts like Jet Blue, which is expanding its transcontinental service. Instead, they subject coach passengers to the indignity of coast-to-coast flights without meals--as wretched as most of those used to be--and instead offer $3 snack boxes with contents worth about 30 cents. Once you've flown Jet Blue, you start wondering how much longer American and its brethren can survive.

Something has to give, but it won't as long as governments allow moribund airlines to remain on life-support. This option hurts everyone except the employees, because it robs shareholders of any opportunity for profit, while subjecting consumers to shabby service. There are really only two choices at a policy level: re-regulation, which would go against the flow of 30 years of history, and radical restructuring. As a first step, the latter requires giving every airline in bankruptcy a deadline for exiting that state, and informing all airlines that their next trip into bankruptcy will take them into Chapter 7 liquidation, not Chapter 11 reorganization.

Perhaps this is one area in which high oil prices will be beneficial, by making the cost of a dysfunctional status quo unsustainably high.

Wednesday, April 06, 2005

Misguided EffortA friend recently shared an email advocating a boycott of any oil company importing oil from Saudi Arabia. Whoever sent this chain letter out into the internet had done some homework, spending enough time on the Energy Information Agency website to tally up the quantities of Saudi imports by company. Unfortunately, they had spent no time researching gasoline supply chains or following merger news for the last five years. Otherwise, they'd have seen just how fruitless such a boycott would be.

Let's imagine a successful boycott of company XYZ, which buys dozens of cargoes of Saudi crude each year and refines them at several locations in the US. Since total demand for gasoline wouldn't be affected (heaven forbid that we drive our SUVs less!) the result would be vacant forecourts at every XYZ station, and more demand at stations carrying the Citgo, Sunoco, Phillips, Hess, BP, and other brands deemed to be "Saudi-free." Rapidly, these stations and the distribution terminals supporting them would run out of product, and they would have to turn to...XYZ, which would have plenty of gasoline in its tanks.

So fairly quickly, the virtuous consumers avoiding XYZ's stations would be filling up elsewhere with gas from XYZ, containing those bothersome Saudi molecules. Meanwhile, the folks suffering the most would not be the management and stockholders of XYZ, who would see their retail margins decline slightly, offset by higher refining profits, but rather the independent business people who actually own and operate 95% of the XYZ stations and have no say whatever in where XYZ buys its crude oil.

In reality, the kind of behind-the-scenes product shuffling I described above happens 24/7 across the US, as refiners and marketers loan each other petroleum products to cover temporary shortfalls and dispose of short-term oversupply. The notion that every gallon of gasoline can be traced back to the same company's refineries and ultimately to their proprietary oilfields hasn't been true for decades. The oil companies were doing supply chain optimization before anyone else had heard of it, and they are very good at it.

So if you're looking to blame someone for high imports from Saudi Arabia, Venezuela, or any other country whose policies you don't care for, you should recall the immortal words of Pogo Possum, "We have met the enemy, and he is us."

Tuesday, April 05, 2005

ChevronTexacal?A few weeks ago it looked possible that a Chinese oil company would buy Unocal, one of the largest independent oil companies in the US. Now it seems they will become part of ChevronTexaco (my old firm). This partially answers the question of how the Super-Majors will spend the heaps of cash they are amassing as a result of high oil prices, and in the absence of the kind of access they really need to top-tier opportunities in the Middle East.

It's always interesting to see the media parroting estimates of "synergies". The traditional view of merger synergies focuses too much on cutting headcount and selling underperforming assets, and too little on genuine upside. This transaction offers a lot of the latter, in my view, and barely enough of the former to affect the bottom line of a company this size.

Consider the overlaps and the voids. Unocal lacks a US downstream, so anti-trust concerns and forced divestments are unlikely, with the possible exception of some pipeline interests. But that also means no downstream synergies. Unocal is heavily focused on natural gas and on Asia, both areas where ChevronTexaco's portfolio could use some beefing up. The biggest overlaps will probably be in deep water Gulf of Mexico exploration and production--a key play for the entire industry--and in Thailand, where CVX's downstream presence via Caltex should be a nice fit with Unocal's big upstream operation. At $10 per oil-equivalent barrel in the ground, it might seem a bit pricey, but not if you think oil has moved into a new trading range.

This deal won't put CVX into the Exxon/BP/Shell league, though it should move them solidly into fourth place globally among publicly-traded oil companies, ahead of Total.

N.B. If I were an equity analyst, I would have to disclose that I own CVX stock.

Monday, April 04, 2005

Missing PlugSaturday’s New York Times described a relatively new but intriguing development: the desire of hybrid car owners to be able to recharge them by plugging them in, not just through normal driving, as intended. Americans love to tinker with their cars, and as cars become increasingly electronic, owners are apt to see them as coming under the “open source” revolution sweeping the software world. As the article suggests, some owners are either paying to have their cars modified for plug-in, or doing it themselves.

This practice raises a number of concerns, affecting carmakers, electric utilities, and consumers. Determining whether it achieves hybrid owners’ goal of improving the environmental performance of these vehicles is hardly straightforward.

First, in terms of the cars themselves, their battery packs and power management hardware and software have been optimized around the assumption that they will be recharged in only two ways: by capturing energy when the car brakes, and by tapping the engine as a generator when the charge level gets low. The batteries are chosen for this type of service, which is normally a shallow-discharge, frequent recharge mode, rather than the deep-discharge mode a pure EV needs. In practice, the metal hydride batteries in most of these cars ought to do both reasonably well, but I suspect the carmakers will see plug-in modification as a warranty-voiding event. That’s a big deal, because replacing these batteries isn’t cheap.

The larger issue is whether plugging in a hybrid really helps the environment (or energy security, for the Geo-Greens out there.) To answer this you need to know two things: what is the incremental generating source on your local power grid, and to what degree does fully-charging a hybrid reduce its driving-cycle benefit? E.g., if the batteries always start out full, where does the energy recovered from braking go? I don't have enough information on the latter, other than knowing it must reduce the perceived plug-in benefit to some degree.

Answering the power grid question takes you into the world of dispatch curves and Clear Skies legislation. If you assume most of these cars will be recharged at night, and that the base-load power for most local grids will be either coal-fired or nuclear (because these plants are hardest to ramp up and down), plug-hybrid driving could be either truly zero emissions (nuclear), or create more emissions than running on gasoline (in the case of coal.) Either way, it would save oil, because so little power is generated using oil.

If I sound lukewarm on the idea, it’s because I think it’s not quite ready for prime time. A hybrid built from scratch around the plug-in concept would be terrific, particularly for consumers with short urban commutes, but the kind of aftermarket modifications described in the Times seem likelier to tarnish the image of all hybrids by making them much more prone to operating problems. That would result in fewer consumers buying hybrids, negating the tremendous benefits even normal hybrids can provide. Anyone wanting a manufactured plug-in hybrid shouldn’t have to wait more than a few years, though.

Friday, April 01, 2005

Killing the GooseLast year I described the internal struggles over Bolivia's natural gas resources as an example of the need for a comprehensive approach to sustainable development. Now it appears that the Bolivian Senate sees it as a chance for larceny bordering on expropriation, as reported by the Financial Times (subscription required.) Raising the combined royalty and wellhead tax on Bolivia's natural gas to 50% will leave the companies that risked their capital and expertise to develop this resource with little chance of earning a return.

While I don't know the detailed project economics in question, it's important to understand the difference between producing gas in Bolivia compared to producing it in Oklahoma. Lacking much domestic industry, most of the gas must be piped to neighboring countries to reach a market. A little knowledge of South American geography suggests the challenges this entails; the pipelines to the closest markets for Bolivian gas are long, expensive and costly to operate. By the time you back the pipeline charges out of the delivered price of the gas, which is probably about $2.00/thousand cubic feet (MCF), the wellhead value of the gas could be under $1.00, leaving less than $.50/MCF to cover production costs.

Finding and producing gas in a remote, landlocked country with minimal local infrastructure isn't going to be very profitable at $.50/MCF. (US gas producers are currently netting $4 or $5 at the wellhead.) Even if you are a avowed socialist leading street protests against the evil capitalist exploiters of your country's patrimony, it ought to be self-evident that running off the only folks who can produce this resource is tantamount to killing the golden goose. If the protesters focused more on how to make the best use of reasonable royalties and less on grinding the foreign investors into the dust, they would stand a better chance of actually having a future royalty stream to divvy up.